WHAT IS SECUR1TISAT1QN

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Securitisation of debt or asset refers to the process of liquidating the illiquid and-ibng term
assets like loans and receivables of financial institutions like banks by issuing
marketable securities againot them, in other words, it is a technique by which a long term,
non-negotiable and high valued financial asset like hire purchase is converted into
securities of small values which can be tradable in the market just like shares?)
Thus, it is nothing but a process of removing long term assets from the balance sheet of a

lending financial institution and replacing them with I Asset securitization is the process
of separating certain assets from the balance sheet and using them as collateral for the
issuance of securities. Securities may then be rated and sold based upon the economic
quality of the assets. Raising funds through the sale of this commercial paper can provide
substantial savings over the cost of traditional term loans.
A technique whereby assets are converted into securities, which are in turn converted into
cash on m ongoing basis, with a view to allow for increasing turnover of business and
profit, is known as asset securitization. The technique provides for flexibility in yield,
pricing pattern, issue risk and marketability of instruments, which is to the advantage of
both borrowers and lenders. The process of trading in the securities that are created on the
backing of pools of mortgage Voans from banks and financial institutions is called asset
securitization. Mortgage loans include housing Joans, car and truck loans, credit card
receivables, trade receivables, etc. "Securitization", in its widest sense, implies every such
process which converts a financial relation into a transaction. Examples include
securitization of relationships such as commercial paper, whkh securitizes a trade debt.

It is a device of structured financing where an entity seeks to pool together its interest in
identifiable cash flows over time, transfer the same to investors, either with or without the
support of further collaterals, and thereby achieve the purpose of financing. Though the
end-result of securifatfion is fin&icing, it is not "financing" as such, since the entity
securitizing its assets is not borrowing but selling a stream of cash flows that was otherwise
to accrue to it.

the capital adequacy ratio. Capital adequacy ratio can also be improved by replacing
the loan assets with the lesser risk weighted assets. Thus, the removal of assets from
the Balance Sheet under a true sale improves the capital adequacy norms.

(iv) Spreading of Credit Risk

Securitisation facilities the spreading of credit risk to different parties involved in the
process of securitisation. In the absence of securitisation, the entire credit risk
associated with a particular financial transaction has to be borne by the originator
himself. Now, the originator is able to diversify the risk factors among the various
parties involved in securitisation. Thus, securitisation helps to achieve diversification of
credit risks which are greater in the case of medium term and long term loans. Thus,
it is used as tool for risk management

(v) Lower Cost of Funding

In view of enhancement of cash flows and diversification of risk factors,
securitisation enables the originator to have an easy access to the securities
market at debt ratings higher than its overall corporate rating. It means that
companies with low credit raring can issue asset backed securities at lower
interest cost due-to high credit rating on such securities. This helps it to
secure funds at lower cost. Moreover/ the criteria for choosing the pool of
assets ensures an efficient cost of funds. In the present context of scarcity of
funds and higher interest rates, securitisation provides a good scope for
cheap funding.

(ui) Provision of Multiple Instruments

From the investor's point of view, securitisation provides multiple new
investment instruments so as to meet the varying requirements of the
investing public. It also offers varieties of instruments for other financial
intermediaries Jike mutual funds, insurance companies, pension funds etc.
giving them many choices.

(vii) Higher Rate of Return ML

When compared to traditional debt securities like bonds and
debentures, securitised securities offer better rate of return along with
better
liquidity. These instruments are rated by good credit rating agencies and
hence more attractive. Being structured assets based securities, they offer
more protection and yield a good return. The bankruptcy/winding up of
the originator does not affect the investors since the payment is
guaranteed
by the SPY. . liquid cash throughtheissueofsecuritiesagainstthem.Undersecuritisation,afinancialinstitutionpoolsitsilliquid, non-negotiable and longterm assets, createssecurities
againstthem,getsthemratedandsellsthem tp_ investors,Itisanongoingprocessinthesensethat assets areconverted into securities,securitiesintocash,cashintoassetsandassetsintosecuritiesand
soon.

Generally,extensionofcreditbybanksandotherfinancialinstitutionsintheformofbillspurchaseordiscountingorhirepurchasefinancingappearsasanassetontheirbalancesheets.Someoftheseassets
arelongterminnatureanditimpliesthatfundsarelockedupunnecessarilyforanunduelongperiod.So,tocarryontheirlendingoperationswithoutmuchinterruptions,theyhavetorelyuponvarious
othersourcesoffinancewhicharenotonlycostlybutalsonotavailableeasily.Again,theyhavetobeartherisk of the credit outstandings. Now, securitisation is a
readymadesolutionforthem.Securitisationhelpsthemtorecyclefundsatareasonablecostandwithlesscreditrisk.Inotherwords,securitisationhelpstoremovetheseassetsfromthebalancesheetsof
financialinstitutionsbyprovidingliquiditythroughtradablefinancialinstruments.

Againfromanotheranglealso,securitisationisaboontofinancialinstitutions.Fromtheriskmanagementpointofview,thelendingfinancialinstitutionshavetoabsorbtheentirecreditriskbyholdingthe
creditoutstandingsintheirownportfolio.Securitisationoffersagoodscopeforriskdiversification.

ItisworthwhiletonotethattheentiretransactionrelatingtosecuritisationiscarriedoutontheassetsideoftheBalanceSheet.That»«oneasset(ill-liquid)isconvertedintoanotherasset(cash).

Definition

Asstatedearlier,securitisationhelpstoliquifyassetsmainlyofmediumandlongtermloansandreceivablesoffinancial institutions. Theconceptofsecuritisationcan be definedasfollows:

"Acarefullystructuredprocesswherebyloansandotherreceivablesarepackaged,underwrittenandsoldintheformofassetbackedsecurities".
Yetanothersimpledefinitionisasfollows:

"Securitisationisnothingbutliquifyingassetscomprisingloansandreceivablesofaninstitutionthroughsystematicissuanceoffinancial

instruments". /

AccordingtoHendersen,J.andScott,J.P. "Securitisationis the process which takeswhenalendinginstitution'sassetsareremovedin one way or anotherfrom the balancesheetofthat
lendinginstitutionandarefunded

Instead, by investorswhopurchaseanegotiablefinancial instrument evidencing this indebtedness without recourse, or in some cases wttti

1 1. ... J^r

(vllt) Prevention of Idle Capital

In the absence of spniritisntirm. canl+al wnut

LIMITATIONS

The use of securitization as a viable financial service, has the following limitations;
Debility to Central Bank
Securitization process may lead to diminishing of the importance of banks in the
financial intermediation

process, by causing reduction in the proportion of financial assets and liabilities held
by banks. This would in turn render more difficult, the execution of the monetary
policy in countries where central banks operate through variable minimum reserve
requirements. A decline in the importance of banks could also weaken the relationship
between lenders and borrowers, particularly in countries where banks are predominant
in the
economy.
Heightened Volatility
The transformation of non-liquid loans into liquid securities, facilitated by the process
of securitization, may lead to an increase in the volatility of asset values, although
credit enhancements could lessen this effect. Moreover, the volatility could be
enhanced by events extraneous to variations in the credit standing of the borrower. A
predominance of assets, with readily ascertainable market values, could, even in certai
circumstances, promote liquidation, as opposed to the going-concern concept for
valuing banks.
Pressure on Profitability
Securitization process might lead to some pressure on the profitability of banks if non-
banking financial institutions, exempt from capital requirements, were to gain a
competitive advantage in investment in Sectaitized assets.

Eroding Capital Base

Securitization could lead to a decline in the total capital employed in the banking
system, thereby increasing th< financial fragility of the financial system as a whole,
both nationally and internationally. With a substantia capital base, credit tosses can
be absorbed by the banking system. But a smaller capital base will entail large losses
to be shared by fewer. This concern applies, not necessarily in all countries, but
especially in thof countries where banks have traditionally been the dominant
financial intermediaries.